The RBA pause and what comes next?

The RBA’s decision to pause this week was dressed up as a short term measure but in reality the true story emerged during the week when the Governor spoke and chart pack was released.

We aren’t surprised and in fact we have been consistently calling a March peak in rates since mid last year. While some see this as a pause, we see it as a pivot. What happens in Australia is also a good precursory for what happens overseas.

The rate pause was dressed up as a “wait and see” measure, but we think this is just the RBA trying to keep its options open if inflation blows out again. We see a different story behind the scenes with concerns within the RBA that the full effect of the rate rises is about to be felt in the second half of this year.

The RBA notes that a growing percentage of households have a minimal buffer on repayments. That buffer will continue to be drawn down in coming months. This is pretty much the same in the US and UK markets where central banks have been waiting to see how quick accumulated savings will be drawn down as rates rise.

It seems that this draw down is now taking place.

According to the RBA’s disclosures this week, around 40% of households have less than 3 months of accumulated payment buffers in offset accounts. This very admission is central to our case that the RBA has not only paused but is starting to think down the line about the impact of its rate rises in 2024.

We doubt the RBA will move higher again given the above and fragility of 10 rate rises in such a short period of time. Inflation is a medium term problem and the RBA is starting to realise that rate rises have actually made property inflation (especially rents) worse, not better.

Again, this is something we have been saying for some time. My vantage point in the real estate development market and colleagues have been telling me that they are actively pricing projects higher, to justify feasibility studies. The RBA has pushed prices higher again – a second order, unintended consequence of rapid monetary policy.

My base case is the RBA holds for the next six months or so, while still flouting the line that it might raise if inflation doesn’t moderate. But in reality, behind closed doors, I think the RBA will be monitoring data around financial stability rather than price stability.

Inflation is under control and it will continue to decline, over the medium term, gradually. Monetary policy has made it worse, not better.

The bond market is starting to suggest rate cuts in 2024 and I tend to agree that next year will be completely different. Inflation will be under control, trending lower and the global economy will be chocked by higher rates. The pause will be followed by cuts.

Aussie 2 year bonds are now trading under 3% compared to a cash rate of 3.6%. The US 10 year bond yield is now in the lower end of the 3-3.5% band range. Global growth expectations are being lowered and Saudi Arabia (together with OPEC) decision this week to lower production has a lot of signalling behind it.

There’s as a saying in markets, if you want to know how China is going, look at what the Saudi’s are doing. I’ll talk more about that next week.

Peter Esho is an economist and Founder of Esho Group. He has 20 years of experience in investments and markets.